caiib super notes: bank financial management: module d: balance sheet management: raroc and profit...
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CAIIB – Super-Notes © M S Ahluwalia Sirf Business
RAROC and Profit Planning
Module D: Balance Sheet Management
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
CAIIB – SUPER NOTES
Bank Financial Management: RAROC and Profit Planning
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
Contents
Coverage:
1. Profit Planning
2. Risk Aggregation and
Capital Allocation
3. Economic Capital and
RAROC
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
PROFIT PLANNING
1.
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
Profit Planning
• Essentially involves Balance Sheet Management – covering credit,
investment and non-fund based income
• Income arises from three sources (Need to be maximized):
– Interest Income
– Fee Based Income
– Treasury Income
• Expenses(Need to be minimized):
– Interest Expenses
– Operating Expenses (Staff Costs and other costs)
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
RISK AGGREGATION AND CAPITAL ALLOCATION
2.
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
Risk Aggregation and Capital Allocation
• Most commonly used approach to estimate aggregate risk exposure is
RAROC (Risk Adjusted Return On Capital)
– Key is matching of revenues, costs and risks on transaction or portfolio basis over a
defined period
– Expected losses are covered by reserves and unexpected losses require capital
allocation
• Second approach is EaR
– Similar to RAROC but depends less on capital allocation and more on cash flows or
variability in earnings
– Ignores the value changes in Assets and Liabilities due to changes in market
interest rates
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
ECONOMIC CAPITAL AND RAROC
3.
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
Economic Capital and RAROC
• Risk Capital: Economic capital required to support the bank’s
financial risk
• Pricing of products should be a buffer against expected losses
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
Risk Capital
• RAROC is part of family of risk adjusted performance
measures (RAPM)
• Risk Capital (RC) = VAR
• RAPM = Profit/RC
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
RAROC Methodology
• Risk Management: Includes measurement of portfolio
exposure, the volatility and correlations of risk factors
• Capital Allocation: Requires choice of a confidence level and
horizon for the VAR measure
• Performance Measurement: Adjustment of performance to
Risk Capial
– Can be based on RAPM Method
– EVA = Profit – (Capital x k) (Higher the EVA, better the project/product)
CAIIB – Super-Notes © M S Ahluwalia Sirf Business
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M S Ahluwalia, amongst other things, is a visual artist, blogger,
blog designer and of course an MBA and Banker from New
Delhi, India.
To know more about him you may visit his blog-site: Estudiante De La Vida